Over the past 25 years, the required contributions to the teacher’s pension system grew substantially as the state developed massive unfunded liabilities.

Michigan has been at the forefront of reforming
its retirement system for state employees. It is time to do the same for the
state-run school employee pension plan.

In 1996, Michigan was one of the first government
pension systems to convert to a defined-contribution 401(k) plan — but it only
applied to those who work for the state itself, not school employees. All new
state employees hired since then are offered up-front contributions to
individual retirement accounts. Those hired previously are still covered by a
conventional “defined-benefit” system, with pension fund contributions
calculated by actuaries using assumptions imposed by politicians.

No comparable reforms have been enacted for the teachers’ retirement system, which operates at an unfunded liability four times larger than the state plan.

State governments are notoriously bad at
estimating how much will be needed to cover a lifetime of future pension
payments for retired employees. Key to this is the assumption that its
investments will return 8 percent annually. This has been problematic and unrealistic.
The state’s returns have been substantially less, averaging only 5.7 percent
since 1997. Assuming a higher investment return reduces the amount needed to
prefund, but missing that assumed rate of return means that gaps develop
between what has been saved and what the state expects to pay out.

This is compounded by policymakers’ decision to
mark pension fund assets to market value just before the market crashed in
2008. This move allowed the state to contribute nearly $200 million less to the
retirement system for a year, but caused spikes in underfunding afterwards.
State underfunding doubled from $6 billion after the adjustment to $12 billion
since the move.

Even under these altered rules, legislators have
failed to provide the required contributions in annual budgets. In the past
decade, the state underpaid its needed retirement benefits by $1.46 billion.

According to a recent state report, Michigan’s
retirement funds will have to earn more than 11 percent on its investments on
average for the next 10 years to get back to fully funded status without a
bailout.

Despite the dire situation of its teacher pension
fund, however, Michigan has been ahead of the curve nationally in reforming its
state employee pension system. With its 1996 state employee reforms, Michigan
has saved up to $4 billion in unfunded liabilities. The system is still
underfunded, but less so than many other states.

Last year, Michigan took another big step toward
long-term fiscal sustainability by also reforming the health benefits the
Legislature has chosen to give retired state employees, following the lead of
some of the state’s local governments.

By offering a defined-contribution plan and
cutting back on retiree health expenses, the state has been a leader in
reforms. But this has only applied to the state employee pension system. No
comparable reforms have been enacted for the teachers’ retirement system, which
operates at an unfunded liability four times larger than the state plan.

The school pension fund is different than the
state pension fund because there are school districts everywhere, while state
employees are concentrated in Lansing. There are 243,000 members in the
teachers’ retirement system, while the state system has only 54,000. School
employees make up a substantial number of constituents in every legislative
district.

This provides more political pressure on reforming
the teachers’ pension fund than on the state pension fund. For instance, the
state made substantial changes to the retiree health benefits offered to new
employees in the state pension fund earlier this year, but has not yet done so
for teachers.

While state and
school employees and retirees should be more concerned with ensuring that the
retirement benefits are affordable and that enough money is set aside, they
have typically risen in opposition to any changes to their retirement benefits.

The school employee retirement system is both
overpromised and underfunded. It’s also unfair to the taxpayers who provide
benefits that few in the private sector receive, and it’s imposing
unsustainable burdens on local school budgets, requiring districts to
contribute an amount equal to one quarter of each employee’s salary into the
fund. Anything less than the reforms already in place for state workers should
be considered a failure.

#####

James Hohman is assistant director of fiscal
policy at the Mackinac Center for Public Policy, a research and educational
institute headquartered in Midland, Mich. Permission to reprint in
whole or in part is hereby granted, provided that the Center and the author are
properly cited.

ISSN: 1093-2240,
SKU: V2012-06

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Summary

Michigan is ahead of the curve nationally in reforming the state employee pension system, but the governor and Legislature must now address a teacher pension system that is underfunded by $12 billion.